Cullen's tax conundrum

The McLeod tax review offers some hope in our quest to attract more foreign investment. But how much New Zealand benefits from the review will depend on how much this government, or its successor, takes on board.

The McLeod tax review offers some hope in our quest to attract more foreign investment.

But how much New Zealand benefits from the review will depend on how much this government, or its successor, takes on board.

The independent tax review panel of five, whose remit was to examine and inquire into the structure and effects of the present tax system in New Zealand and formulate proposals for “improving” it, recommends overseas company investors pay an 18% tax rate to make New Zealand “stand out from the crowd” as an investment destination.

Two options are presented. The first would not distinguish between new investment and existing activities and is estimated to cost $460 million. The second limits the lower tax to new investments by non-residents and is costed at $50 million.

Finance Minister Michael Cullen told the Institute of Tax Accountants 2001 Tax Conference in late October that international tax is one of the areas of “greatest practical interest” to government since it has the potential to stimulate economic growth.

“International taxation is especially pertinent, given the increased mobility of capital, individuals and businesses. Although tax is not the main driver of decisions to locate investment, it can exert some influence at the margin.”

Cullen suggested we need to keep our foreign investment laws under constant review as other jurisdictions are using tax rates to attract investment. “For example, much of Asia offers a lower tax environment for non-residents than the 18% recommended by the review.”

At the conference, Cullen looked at arguments from those calling for a wholesale cut in the company tax rate. For residents investing in New Zealand companies, lower company tax would be offset by them paying more income tax. But for non-residents, the impact can be much more immediate and far-reaching, since lower taxes can reduce the cost of capital to New Zealand firms, he said.

Cullen added that cutting tax just for non-residents would cost less revenue than cutting to all, but he raised what the review panel saw as a conundrum.

“On the one hand, New Zealand does not want to induce our most mobile taxpayers to consider moving from New Zealand,” the panel said. “On the other hand, New Zealand does not wish to adopt a built-in tax incentive that causes people to see a tax advantage in investing offshore rather than in New Zealand.”

Herein lies the nub of the problem, which was also raised by IT industry experts in Computerworld last week (see McLeod tax plan not enough). Restricting a lower tax rate to non-residents might encourage New Zealanders to move offshore.

If our corporate tax rates are greater than some other countries (and they are), including the much-touted Ireland, there is less incentive to set up shop here.

Auckland software development company Right Hemisphere co-founder Dave Revill agrees an 18% company tax rate might be insufficient when other countries are offering 10%. He suggests this is what New Zealand should offer for new investment from non-residents.

Revill also wants a lower top rate of income tax, believing the current 39% rate deters skilled migrants and skilled New Zealanders from returning home. “The intellectual capital that these people have is as mobile as traditional investment capital.”

Revill says once these people arrive here, they are likely to stay because our low labour costs at the current exchange rate will give new IT businesses a major competitive advantage.

While individuals are attracted by our lifestyle, serious investors are not, and the government has to do more to attract skilled people “to commence the process of growing the cake”, he says.

Cullen’s arguments point to what he perhaps should do, even if he might not want to — though he has to sell any changes to a potentially sceptical Labour-Alliance administration.

But if he says lower company tax for residents means he receives more in income tax from them, what has he to lose? Ireland and others have learnt it is better to get 10% or so of a large cake than 30%, 35% or 40% of very little.

You might call it Cullen’s tax conundrum: where taxing less could bring more.

Greenwood is Computerworld's human resources reporter. Send email to Darren Greenwood. Send letters for publication to Computerworld Letters.

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